In 1921, a Swiss psychiatrist published a book called Psychodiagnostik. Trying to understand why people have different responses to identical stimulus, he explored the reactions of his patients to the same 10 inkblots.

The author's name was Dr Hermann Rorschach. His technique of getting people to reveal themselves became known as a Rorschach test.

In some ways the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry has become a Rorschach test of its own.

The terms of reference are so broad and so vague that what you see in them depends on how you view the sector.

Stewart Oldfield, former equity analyst at Field Research, says the inquiry will almost certainly weigh on returns to shareholders.
Luis Enrique Ascui

There are a few specific topics that the commission has been asked to look at including recruitment, remuneration and industry codes of conduct.

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(Perhaps the inquiry could look at getting these down to a manageable number of pages, the current banking code of conduct – which will be replaced by Christmas – runs to 72 pages).

But by and large, the only prescriptive component of the draft is the time line, which demands a final report in a little over a year – on which there is near universal agreement that it is insufficient.

So where will it go and where should it go?

The Australian Financial Review has consulted a group of academics, analysts, investors and lawyers about what the royal commission could focus on and, indeed, what it should. Will it deliver a blueprint for Australian financial services or has it already been compromised by politics?

Professional investor Peter Morgan isn't getting too worked up about the impact of the inquiry.
James Brickwood

The academics

The decision to overlook providers of credit has attracted considerable comment from most observers. Professor Kevin Davis is also puzzled by the omission.

The University of Melbourne finance professor and panel member of the 2014 Financial System Inquiry chaired by David Murray says that while the terms of reference are extremely broad, the decision to limit the interpretation of financial entity was curious.

"It is interesting that they have defined financial entities as anyone with an AFSL [Australian Financial Services Provider] and not credit licenses when the majority of interest from the public has come from the mis-selling on the loan side of things" Davis says.

He is also perturbed by the focus on culture. He questions what evidence you might submit to prove a concept that can't be measured has an impact on misconduct.

"How do you measure something like culture? And how does a leader of a large organisation like a bank have an impact on culture? They can try and instil a sort of ethos throughout the system but to control the actions of every staff member is very hard" Davis says.

He says these questions can be better answered through a prism of risk. The operational risk that certain products are mis-sold. He asks whether banks can indeed rely on community expectations to guide staff or whether they need hard and fast policies and procedures for every possible situation.

Dr Patrick McConnell is a visiting fellow with the Macquarie University Applied Finance Centre in Sydney and an expert in operational risk. He says it's vital that the inquiry spends considerable time in the institutional market and therefore wants to see misconduct in the FOREX, BBSW and AUSTRAC debacles carefully examined.

"There are a lot of complaints from the retail sector and there should be, especially in areas such as life insurance. But you aren't going to hear as many complaints about behaviour in the institutional parts of the business."

The terms of reference give the commissioner a way out on the matters McConnell mentions.

Point 4 says the commission is not required to inquire into matters that might prejudice, compromise or duplicate existing inquiries, investigations or proceedings. McConnell however believes that events such as the manipulation of foreign exchange deserve closer scrutiny.

"The FX manipulation was a disgrace. It was certainly highly unethical if not bordering on illegal. The resulting fines were nothing" he says. "And BBSW, well, you've got Justice Jagot's comments on that. Excoriating".

McConnell believes the relatively small fines from the FOREX findings and the BBSW settlements were symptomatic of regulatory architecture that is no longer working.

"I'm not saying that the system is irretrievably broken, it's just not fit for purpose" he says.

"We are not talking about isolated cases of misconduct. It's happening across retail banking, wealth management and institutional banking. It's happening at institutions big or small, local or offshore. It's systemic."

Like other experts The Australian Financial Review spoke to, McConnell says there is a risk the royal commission is a missed opportunity for reform. He accepts that the theatre of an inquiry demands that a few will be crucified for the sins of many, but he hopes it leads to change.

He also says it is vital that Australia gets a better banking regulatory system at the end of the process and hopes the Commissioner, former High Court judge Kenneth Hayne, makes submissions to that effect because the terms of reference ask for its "findings" and "any recommendations" separately – the implication being the commission may not have time to make detailed recommendations.

"If all it does is air a lot of dirty linen and flog a few bankers in public then it will have failed" McConnell says.

The analysts

By far the most important inclusion in the terms of reference from any royal commission is a line granting additional powers to investigate other events as they come to light, according to CLSA veteran bank analyst Brian Johnson.

In this instance it occurs in the middle of the document under 1(h) where it says "any matter reasonably incidental to a matter mentioned in the above paragraphs".

"Past Australian royal commissions have tended to discover issues well beyond their initial remit" Johnson says.

CLSA notes the two most recent royal commissions are instructive of how much wider they can go. The inquiry into child sexual abuse in the Catholic Church, for instance, was broadened to include all institutional responses to child sexual abuse.

Likewise, the inquiry sparked by the treatment of Dylan Voller at the Don Dale Youth Detention Centre, later broadened to include the protection and detention of children throughout the state.

The more bearish analysts fear that mission creep in a royal commission is unavoidable and therefore the prospect of the inquiry dredging up another AUSTRAC or another BBSW is quite real.

Others are more relaxed about what might take place.

It has been noted the costs will be comparable to a large acquisition without the associated restructuring costs. Estimates have been as high as $150 million for one of the bigger banks. The dollar figure cost of administration may be 1 per cent of net profit.

Others say the royal commission may be crimping shareholder returns already.

​Stewart Oldfield is a director of industry research house Field Research. It connects institutional investors with primary sources of industry data and insights. He says the inquiry will almost certainly weigh on returns to shareholders.

Taking note of the bank's response to the crippled NZ diary industry, he is forecasting a rise in non-performing loans that remain on a bank's balance sheet and cannot be recycled to more productive pursuits. He calls these non-performing loans "Zombie loans".

"The banks are much more reluctant to put people under and enforce that security because they are going to get grilled in parliament or a royal commission. They are more inclined to put these loans in the too-hard basket and that has inevitable implications on their return on capital and therefore their returns to shareholders," Oldfield says.

The investors

One investor we spoke to says a royal commission will not be the deciding factor in whether the banks are a good or bad performer in the year ahead. The investor, who declines to be named, says that on the face of it, the royal commission is not something that will affect their strategy.

"Will credit growth be weaker? No. Will they have to divest? Maybe. Will it add to costs? Yes, but it won't be material" the investor says.

This view has been supported by movements in equity markets which shrugged off the idea within 24 hours. The lack of selling pressure is also congruent with an amorphous terms of reference.

Peter Morgan is another observer who isn't getting too worked up about the impact of the inquiry. The private investor and former head of equities at Perpetual has been a buyer and seller of banks over the years.

He says any examples of misconduct uncovered are unlikely to be on the same scale as in the UK and the US. The BBSW trial was not a good look but also not quite the same scale. Problems within a culture are an "eye of the beholder" issue he says, and hard to define.

"That's not to say there will be no problems but there won't be anywhere near the angst. The funny thing is I reckon they are a bit early, you don't find out who is swimming naked until the tide goes out" Morgan says.

He says the relative strength of the housing market will mask problems within the banks and cites the abnormal proportion of interest-only loans as a symptom. And that it could be a different story in 18 months if the housing market does turn over.

"The terms could have been stronger and a bit more of a focus on property lending would have been a good idea. It's hiding at this point in the cycle, bad debts have never been lower but it can't last forever" he says.

The always popular issue of banker remuneration should remain high on the agenda according to Morgan, who is not convinced that efforts to align the interests of both shareholders and executives have been successful.

"Bank executives are remunerated short and lend long" he notes, comparing the five-year vesting period for long-term incentives with a 25 or 30-year loan.

The lawyers

Minter Ellison partner James Beaton says the challenge for the royal commission and Hayne will be twofold. The first is to assemble an organisation that functions efficiently as a team. This start-from-scratch group will be going up against the banks' well-established legal teams.

The second – no less immediate – challenge is to figure out where to focus their attentions and how to divide up the time. How much for each subject? How much for hearings? How much for victims? How much for the banks? How much for the judgment?

"There will be a practical constraint in terms of the availability of hearing time and as a result the commission will need to carefully prioritise the matters it wishes to examine in public hearings" Beaton says.

Maurice Blackburn's principal of superannuation and insurance Josh Mennen says it is possible the terms of reference will be tightened before they are finalised and that would be preferable.

"If you look at 1(a) it says it's going to look at the 'nature, extent and effect of misconduct by a financial services entity'. That's very open ended. It's sufficiently broad to cover all the relevant issues but the specifics need to be laid down", Mennen says.

He says the time constraints present a problem as many of the subjects are complex and deserving of thorough consideration.

He suggests considering the approach used in the Royal Commission into Institutional Responses to Child Sexual Abuse, which involved multiple concurrent hearings and an advocacy organisation for victims.

"In order for the royal commission to be legitimate it needs to have victims at the centre. While it can't hear from all of them because there are tens of thousands of them it does need to hear from a good number to get to heart of the issues," he says.

Mennen says it should not discount the role of cross-selling in the vertically integrated business model – the same model the banks have deployed in Australia for many years and have only just started to roll back with planned divestments from ANZ, CBA and NAB.

"I've acted for hundreds of people who have suffered investment losses and have had devastating outcomes with respect to life insurance where they have been pushed into bank-owned products and would have been much better off if they remained in their default industry super fund or pre-existing insurance policy."

He says life insurance in particular needs to be closely explored. The churning of insurance policies by sales people, mental health discrimination, blanket exclusion clauses, oppressive surveillance techniques, doctor shopping and the delaying/denial of legitimate claims are all deserving of thorough examination. Mortgage lending practices also need scrutiny.

"We are only now about to see the losses from fast and loose lending as property prices cool in capital cities. Interest-only loan periods are maturing and about to become principal and interest and that's going to push thousands of people into mortgage stress," he says.

Mennen says the decision to exclude mortgage brokers from the process is one of the more obvious shortcomings.

"The commissioner will have broad discretion to allocate and prioritise but he should not be hobbled from the outset. If he decides that one thing or another doesn't get a run that's a matter for him and can be justified but there's no reason why mortgage brokers who have sold billions of dollars worth of mortgages based on inaccurate info should not face scrutiny."